Pub. 7 2019 Issue 2

10 The Community Banker www.mibonline.org PROTECTING SMALL BUSINESS BORROWERS Featured Assoicate Member N o one ever believes they are going to be disabled. The word conjures up images of wheelchairs and hospital beds – places most people could never imagine themselves. But disabilities happen every day. People get sick. People get hurt. It happens at work and at home and at all the places people play, and it can happen to anyone. For lenders who are working with customers planning to open their first professional practice, expand their business or add locations, the possibility of a disabling injury or illness must be considered. If that commercial borrower gets sick or hurt during the term of the loan, is there a reasonable plan for the lender to be repaid? Perhaps the borrower has a Business Overhead Expense (BOE) insurance policy. This insurance covers the costs of running the business while the owner is unable to materially participate due to a disability. The expenses covered by a BOE policy include recurring charges like staff wages, utilities, rent or mortgage payments, taxes and commercial loan payments. Unfortunately, BOE insurance typically only has a benefit period of 12 to 24 months. This is sometimes insufficient, depending on the loan term and the duration of the disability. Also, if the borrower purchased the insurance before taking the loan, the benefit amount may not be enough to cover all expenses. In this case, the borrower will pick and choose who to pay. Maybe the borrower has their own individual disability income insurance policy. If so, they likely have a benefit amount that is 60-80 percent of their income. It is possible to execute a collateral assignment so that a portion of the borrower’s insurance benefits are paid directly to the lender. But this is a terrible idea for the borrower. He or she is going to need those insurance benefits to pay their personal expenses – rent, car payments, food, and more. It’s a bad idea for the lender too, because the goal is to get the borrower back to working at their business. Diverting this vital cash flow from their household is only going to stress the borrower and the business, making it more likely to fail. The lender may offer credit disability insurance (or a debt cancellation benefit with a disability trigger) to the borrower. If purchased, this may provide up to a $1,000 monthly benefit paid directly to the lender to apply to the loan. This can sometimes be an attractive option due to the limited underwriting credit insurance requires; however, commercial loans often have payments that exceed the benefit amount. Some coverage is better than no coverage, but like the other options, this is not a perfect fit. Loan Indemnification Disability Insurance is specifically designed for bank loans. The policy is set up to provide customized benefits tailored to the stipulations of the loan agreement. Benefit amounts can greatly exceed those of credit disability insurance (up to $5,000/ month in many cases) and cover the monthly or balloon loan payments. Unlike BOE, benefit periods will extend to the end of the loan term. There is no coordination of benefits with other insurance, which means that if there is other disability insurance in place, the insured will be able to keep all their personal insurance benefits to pay for their personal expenses. Loan Indemnification policies are individually underwritten. Typically, the applicant cannot have chronic illnesses, chemical dependency, or mental or nervous disorders in their health history. Underwriters also look at the work the applicant performs. These policies are issued on an “own occupation” definition of disability, which means they are considered disabled if they cannot perform their own job. This is precisely the way the lender wants the definition of disability to be measured, because if the borrower can’t do their job, the loan payments are going to be paid by the insurer. Disability insurance makes small business loans more secure. Lenders see the income statements and balance sheets of their borrowers. How many months could a typical small business owner be out of work before the business suffers and the loan performance is in jeopardy? Not many. To their credit, community bankers work with their commercial borrowers to keep loans performing even when problems like disabilities arise. However, when disability insurance is backing the loan, that outcome is a lot easier to achieve. By Robert Uribe, Bison Mountain Financial